Fed's Kohn: Inflation Goals Can Stabilize Market Views

Reuters

Friday, 21 Sep 2007 | 8:15 AM ETReuters

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Federal Reserve Vice Chairman Donald Kohn, who has opposed setting inflation targets at the U.S. central bank, Friday said inflation goals can hold expectations steady and provide workers and businesses more certainty about the course of inflation.

"Evidence has accumulated to suggest that stock prices, interest rates, and measures of inflation expectations seem to vary less in economies in which the central bank has an explicit long-run goal for inflation," Kohn said in remarks prepared for delivery to a conference in Frankfurt.

Kohn sought to dispel any notion that he has changed his mind on inflation targeting, a policy approach Fed Chairman Ben Bernanke has endorsed.

"Before anyone jumps to the conclusion that Frankfurt is a stop on my road to Damascus, let this Saul state that for me the case remains open," he said in the speech, which was to be delivered at conference celebrating the 50th anniversary of Germany's Bundesbank.

However, Kohn enumerated several benefits to setting explicit goals for inflation. A formal target represents a national embrace of a goal and publicly establishes the priority of maintaining price stability, he said.

The Fed has been discussing whether or not to adopt an explicit inflation goal as part of a review of its efforts to communicate more clearly to the public.

Kohn's comments, which were made available to reporters in Washington, appear to signal growing momentum behind some form of inflation targeting at the Fed.

The Fed vice chairman said the central bank has been discussing "whether mechanisms could be put in place that could better anchor inflation expectations in a manner consistent with the institutional framework of our dual mandate."

One benefit to inflation targeting, Kohn said, might be political.

"An important effect of ... public acceptance of price stability is that it erodes the standing of those who would direct central bank action toward other ends," he said.

Even so, Kohn said the U.S. central bank's dual mandate of fostering maximum employment and stable prices produces results that are not too different in practice from what central banks with flexible inflation targets are able to achieve.

"The dual mandate has come to be interpreted as assigning us the responsibility for attaining price stability in the long run, which will bring with it maximum employment, and of being mindful of resource utilization in a succession of short runs that make up the long run," he said.

Discussing the housing slump that has forced the Fed to shift the principal focus of its concerns from inflation to worries about growth, Kohn said it is too soon to say what went wrong.

Inexperience with the market for riskier borrowers, complex and opaque financial instruments intended to disperse risk, and fragmented regulatory oversight magnified the swings in the housing cycle, Kohn said.

Low short-term interest rates also played a role in inflating the housing bubble, he said.

"Low policy interest rates early in this decade helped feed the initial rise in house prices," Kohn said. "However, the worst excesses in the market probably occurred when short-term rates were already on their way to more normal levels, but longer-term rates were held down by a variety of forces."